Guy Haselmann
Overview
Today’s global economic system is more intertwined than at any point in history. For the past 30 years in particular, globalization and the Theory of Comparative Advantage have been alive and well. Technological advancements and transportation improvements have truly ‘shrunk the world’, allowing more countries to participate and benefit from international trade.
The globalized world economy has become a vast network of complex supply chains, interconnectedness and co-dependence. The benefits have been wide-spread and done more to lift the human condition, and more people out of poverty, than any development in history. However, this increase in economic complexity has magnified global vulnerabilities, opening up the risk of rapid and large-scale failure and contagion: a period of anti-globalization. COVID-19 is the catalyst that is triggering a supply-side crisis; one that is further exacerbated by a simultaneous demand-side shock.
Consensus View
The consensus view seems to be that the COVID-19 will die out with warmer weather; after all this is what typically happens with the common flu. In terms of markets, most believe that governments and central banks will come to the rescue with proactive stimulus which will be exceptionally good for markets, because the economy is viewed to be on solid footing already. The stimulus will come to be viewed as an over-reaction that merely serves to provide more economic fuel, particularly once the Coronavirus sputters away. This scenario is logical and possible, but not a view that I share.
In thinking about where markets are headed, for this note I am more focused on the supply and demand shocks currently in motion particularly against the backdrop of the state of our economy. An understanding of the path of financial markets in recent years will also be helpful to thinking about where they may go next.
A Globalized World
In a globalized world economy with highly complex lines of production, there are many critical links that tie production to delivery, and ultimately to world trade. Most people take simple things for granted: grocery stores and pharmacy shelves being stocked; money accepted in exchange for goods and services, the train arriving on time, and their mobile phone and internet working.
People notice the immediacy of things, but not the conditionality from which it emerges. People rarely think about, or see, the constraints to critical infrastructure or the factors that provide for social stability.
A global pandemic is good reason to shift one’s thinking to consciously considering them. No one wants to test the legitimacy of the old adage that we are only nine meals from anarchy. The worst case scenario of a pandemic causing a simultaneous supply and demand shock could be so highly disruptive that it is something that every market participant and fiduciary must give thought to.
Certainly, there are groups of individuals who need to go to work to provide services that support critical infrastructures. What happens if not enough of them go to work? What happens if manufacturing plants or parts factories close? What are the demand impacts when people are told not to go anywhere where a large number of people gather? What happens, for instance, if truckers do not receive their normal supplies for delivery, or if they refuse to deliver to towns with a high percentage of confirmed COVID-19 cases? All kinds of spillover effects could happen within a few days: food shortages, hospital supply shortages, garbage piling up, US mail stopping, gas shortages, power grids and sewer system troubles, ATM’s running out of cash etc.
I believe Liebigs’s Law of the Minimum can be used to understand a globalized world with its highly-precise and efficient supply chains. Today’s extreme efficiencies mean that it would take only one failure in the chain to stop or impact production and delivery. On average businesses have around 15-20 days of inventory. Production is not limited to the total level of resources, but rather by the scarcest resource. You can’t build a car without the tires or the rubber used to make them. COVID-19 has already dramatically impacted supply-chains as factories in China and elsewhere have shut.
A Ford F-150, for example, has well over 10,000 parts. Their parts suppliers have, say, 1000 suppliers of their own, who in turn have, say, 100 suppliers. This is a crude calculation, but that is a permutation of 1 billion pathways. Dun & Bradstreet reports that 5 million companies have a tier one or tier-two supplier in the Wuhan region. A shut parts factory in China could easily lead to the closing of a manufacturing plant in another country.
A more precise example comes from a friend of mine who was a U.S. Air Force officer responsible for extracting intelligence from aerial photography. He told me the story of his training from WWII photos from near the end of the War showing many German aircraft sitting idle - and no one could figure out why. After the US invaded Germany, they found out that the planes had everything they needed to be operational except the ball bearings; a direct result of the ball bearing factory in Schweinfurt being bombed.
As fears grow and governments impose restrictions against human gatherings, demand shocks will follow. The result will have a cascading effect across businesses, economies, markets and society. Such disruptions do not proportionately or linearly increase with time, but rather cause spillover effects that accelerate disruptions. A classic contagion.
The Catalyst For a Catastrophic System Failure?
COVID-19 could possibly be the catalyst for a double-whammy supply and demand shock that breaks extreme market valuations and breaks the smooth functioning of the financial system.
Slow response time and misleading early information by governments and their institutions (particularly in China and Iran) have, and will, significantly damage the effectiveness of the policy actors who are attempting to manage the crisis. Distrust of official information can be highly damaging. COVID-19 has the potential to lead to catastrophic system failure. Markets, international trade, economic output, and social stability are all at risk.
Todd Strandberg
In my first post for last month, I said, “I believe that the coronavirus will ultimately be contained before it reaches the level of a global pandemic. I think Bible prophecy will be the key reason why. We are in a state of profound financial risk. A global lockdown on economic activity related to the effort to fight the virus would certainly push us over the edge.”
The virus has now spread to the point where it can now be called a pandemic. Dow Jones has had its fastest collapse from a record high since 1928 but, so far, the economy has not gone into meltdown mode. If we are going to witness yet another monetary miracle that saves the financial system from a depression, this one will leave no doubt that God rules over Wall Street.
The sharp decline in stock prices puts us at risk of seeing a systemic collapse in our financial markets. In recent years, stocks have been largely rising based on companies issuing bonds to buy back their own shares. Because their stock has increased in value, banks would gladly loan firms money to finance more purchases.
Uncle Sam gets a huge chunk of his taxable income from capital gains on stocks. A chart of the Treasury’s income and the Dow Jones are nearly equal to each other. This connection is the reason why President Trump starts yelling at the Fed every time the Dow takes a dive.
Some people in China have been in financial lockdown for over a month. The lack of work has left workers and businesses with debts that can’t be paid. Beijing responded to the financial crisis by telling banks to give lenders a three-month grace period. Ultimately, the debt will have to be forgiven or added to the Chinese national debt.
For well over 10 years, Terry and I have maintained that the economy is going to hold together until the rapture. Because Jesus said his return for us would be like the days of Noah or tranquility, we think that time is now. The days-of-Noah factor is an explanation for how the stock market has been able to delay the consequences of our unmanageable debt load. The following five events should have popped the financial bubble:
– The 2008/2009 Housing Bubble should have been the Great Depression II.
– The unmanageable debt loads of nations were magically lifted by rates going below zero.
– The trade war with China had no impact on the US economy.
– We hit several record highs during the Impeachment of President Trump.
– The total collapse of the Repo market in Sept of 2019 was a snoozer.
– The unmanageable debt loads of nations were magically lifted by rates going below zero.
– The trade war with China had no impact on the US economy.
– We hit several record highs during the Impeachment of President Trump.
– The total collapse of the Repo market in Sept of 2019 was a snoozer.
The coronavirus outbreak appears to be the most serious threat to the global economy in the last 100 years. In the next few months, America is going to either become a very scary place or we are going to think how in the world did we dodge another bullet. The day will come when a third option takes all believers to a place where the coronavirus can never reach us.
“So likewise ye, when ye see these things come to pass, know ye that the kingdom of God is nigh at hand” (Luke 21:31).
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